Motley Fool Money - “Cash doesn’t lie.” Peloton’s Predicament

Episode Date: August 15, 2022

Peloton announces more layoffs and store closings. (0:21) Jim Gillies discusses: - How challenging Peloton's balance sheet is right now - Why Peloton will almost certainly have to raise money - The retail landscape when some of the biggest companies are set to report earnings - Why Costco is his favorite retail stock (followed closely by Home Depot) (18:41) Some companies are pulling back on investments, but others aren't stopping. Ricky Mulvey and Sanmeet Deo look at some businesses playing offense in a tough environment. Stocks mentioned: PTON, WMT, TGT, HD, LOW, COST, SHOP, AXON, XPOF, NFLX, TTD Host: Chris Hill Guest: Jim Gillies, Sanmeet Deo Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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It's a big week for retail, but before that, things just got tougher for Peloton. Motley Fool Money starts now. I'm Chris Hill and I'm joined by Motley Fool Senior analyst Jim Gillies. Happy Monday. Thanks for being here. Thanks for inviting me, Chris. Let's start with Peloton, which is cutting nearly 800 jobs, closing some amount of its locations. And along with these moves, Peloton is raising prices on some of its equipment, And I'll just spot you up with the most illuminating comment from CEO Barry McCarthy, who said in a memo to employees, we have to make our revenues stop shrinking and start growing again.

Cash is oxygen. Oxygen is life. And I don't disagree with that, Jim. But when you and I were chatting earlier today, I said to you, when I first saw this story, the immediate thought I had was this seems like a panic move. Yeah, you're going to get me in trouble, Chris. Oh, it's one of those shows. Good.

Peloton. Yeah, it's a panic move. And yes, he's entirely correct of everything he said. Might have been nice if the founder, former management who ran this truck into the dirt might have actually, I don't know, thought about that once or twice before, as I said, running this truck into the dirt. This is a company. Oh, where's my notes for this here? This is a company that has in the most recent balance sheet. I think they're going to report their fourth quarter fiscal earnings. I think they have a June fiscal year, so they're reporting late August if last year's anything to go on. Most recent balance sheet, $1.4 billion in inventory moldering on the balance sheet.

1.9 billion in cash burned in the first three quarters of the present fiscal year. Nice as the CEO to tell us that cash is oxygen after starving the business. Not his fault, but the entire management suite starved the business. This is a business where the CFO, I believe, last November, the now former CFO on the conference call. No, we don't need to raise capital. And I think eight days later, they raise capital. This is a company with $880 million in cash on the balance sheet.

Roughly the same amount as the debt on their balance sheet. Now, fortunately for Peloton, the debt on the balance sheet is all convertible debt, doesn't convert, I believe, until 2020. that the convert price is well over $100. There's no danger of this. When we get there, there's certainly no danger of this company needing to put shares. They'll have to pay that back. But hey, you know what, if the fire's not out by then, it won't matter.

I don't know what credit line available. This is a company that's probably going to have to raise capital again, frankly, in the next quarter or two, because they're burning $600 million a quarter, the last three or four quarters in a row. So they've got negative product gross margin, which I guess makes sense why they're saying, hey, we're going to raise prices. Might be nice to not lose money on every single bike and treadmill they put out the door. Product revenue was down 40 percent year over year, 25 percent quarter over quarter of Q2 to Q3. And did I mention that, to put into perspective, that 1.4 billion in inventory on the books, that's up from 900.

137 million at the start of this fiscal year, it's up from 245 million at the end of fiscal 2020. This is a company that is inventory bloated themselves to, frankly, near death. And I am reminded when I see what the CEO said, and again, it's not his fault. He came in from, I believe, Spotify. I think he was from Pandora before that, which of course was, I believe, purchased by Spotify. Or maybe that was serious. Anyway, the man has some. He was on Netflix at one point.

Yeah, okay. I just, I'm reading his bio here off Cap IQ, so I think his most recent gig, I don't know, but he was, he has, yeah, he was at Netflix's CFO, I think, from 99 and 2010, it says here. More recently, he was at Spotify. He does have financial chops, so that's good, like, you know, because, you know, this is a guy who's going to understand, you know, hey, we're in trouble. I am concerned he's come along a little too late, and I'm always reminded when a service, something like this comes along, I'm reminded of, as I'm often reminded in situations like this,

by a quote from Warren Buffett or Uncle Warren E. Buffett. The quote is, when a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. And the economics for Peloton went over the cliff real fast. And like I said, in their most recent quarter, they burned over $700 million. They've got $800 million in cash. So do you really want to be raising? And I mentioned that prior capital raised at the CFO apparently didn't even have a week's

view into her business at the time, or eight days, sorry. They raise capital, I believe in the lower early 40s, dollar per share. Stocks in the low teens right now. The more you have to raise capital via equity means, the more you're going to dilute present shareholders. So for those who have held through like a 90 percent drop, and I'm sorry, I'm so dower out of the gate. You fed me the disaster going here.

We'll be better in a bit. If they do have to raise capital, and I kind of hope they don't for shareholders who still home this thing, but I'm not seeing a lot of, I'm not seeing a lot of turnaround potential. Just to go back to one more point, when they said, you know, that we need to raise prices. They're going to raise prices. They're raising prices on their bikes by like 500 bucks a bike, and I think it's 800 bucks per unit by the treadmill. But remember how I mentioned they had negative gross margin on, like, they're a moving product

just to get it out the door the last three quarters. Like, it's already not selling, and now you're raising the price. Good luck. And I don't have a lot sunnier disposition to say here, I'm afraid. Well, I didn't ask you to come on just for your sunny disposition. Good. Before we move on to retail, though, what would you ask McCarthy on the conference call? assuming they come out with, you know, a report that does not indicate some radical reversal

of fortune, what is the question you would ask? Would it be around a capital race? Because it does, I mean, when you just run the numbers, it's hard to imagine they don't get money somehow, somewhere. They have to get money somehow, somewhere. I have a difficult time believing, And belief is always a terrible word to use with investing, because I can believe a great many things, but cash kind of doesn't lie. This is a company that burned about 735 million in the most recent quarter, about 550 million in the quarter before that, about 645 million the quarter before that. Like I said, they've got about 880 million cash on the books.

Pretty much their value that. Where is your cash coming from, Barry? Where is your next capital coming from? Because I think this is a business that they have. You have to demonstrate you're going to survive the next year. And then you can talk about growth and maybe adding to those subscriptions. The subscriptions are actually monetizing fairly well. You know, people who love their peloton's, you know, the number of fitness sessions after

spiking during the pandemic with a reopening world, the degradation there is trailed off. And they look like they're doing fairly decently. It's a small sample set, so I don't want to draw any great conclusions there. But there's some optimism. Like to get to be optimistic in three years and have this turnaround and they talk very directly, which I like on the most recent shareholder letter, the third quarter shareholder letter, although that's a pet peeve of mine as well, that they talk about, hey, you know, turnarounds are hard, turnarounds are hard, we're a turnaround now. Okay, good. So you seem to have a reasonable

appreciation of where you are in the pecking order at this point. My questions would circle around, you know, what is your fire suppression plan for the next year? And then we can talk, Once the fire is out, then we can talk about your turnaround, because how, especially heading into a recession when, assuming we have a recession, I have some thoughts on that as well, but assuming that, you know, the popular opinion of we're heading into a recession is in fact true, jack at a price on a souped up treadmill that I have to pay 60 bucks a month for to get a subscription, It's probably not going to clear the books of that bloated inventory. Let's move on to retail then, because it's a big week.

Now that I've just killed it. It's a big week for retail. We've got earnings reports coming later in the week from Walmart, Target, Home Depot. I don't remember retail, big retail, being as weird as it is right now. And when I say weird, I'm referring to the fact that that in general, the major retailers tend to travel in a pack. The fortunes of one tend to reflect the fortunes of another. This is certainly the case for years now with Home Depot and Lowe's, where they report earnings one right after the other. And whatever, you know, it's much more newsworthy if they don't have similar results than if they do. But at the moment, in part because of what we got three months prior from Walmart and Target with their inventory debacle, I don't have a great sense

of the retail landscape, which is why I'm looking forward to this week, because I feel like we're going to get some more clues into things like inventory controls, back-to-school shopping, and possibly even the earliest of indications around year-end holidays. When you step back and look at retail, does anything stand out to you in? particular? We certainly got that kind of negative surprise, negative reporting from Walmart and Target last go-round. Neither of those companies terribly excite me. They are certainly bellwethers, and we should pay attention to them. And it wasn't just Walmart and Target, of course. Like even going down the quality chain to guys like big lots or whatever, it was pretty ugly,

kind of across the spectrum. Because, yeah, like, inflation seems have caught them flat-footed, so everybody had their inventory spike, inventory spiked because, you know, in part, or a lot of their expenses also got kind of quashed because the higher-cost inventory is now moving through your system. I'm not real, like I said, as an investor, I'm not real interested at these large specialty non-differentiated names. The one I love to watch and love to follow is, which you didn't mention, and maybe I'll hit that before we get over to the home improvement folks, is Costco. They're in a bit of a different reporting schedule. I think they report third week of September, because I believe they're on a June or a September fiscal year. What would

September. But, you know, Costco is one of those stories where, I mean, they are, I think Costco is hitting on all cylinders. I think, to steal a Ron Grossism. I think Costco is, every time I walk into Costco and walk out of Costco, having, you know, having dropped 250 bucks on, you know, an order that I plan to be under 50, I was like, man, I don't own enough Costco. There are, and the really interesting thing to me about Costco is for years, a lot of people would talk about how Costco passed on so much of their, so much. Basically, you were buying most goods close to cost because they were making up all of their profits essentially on selling memberships.

And for a time, that was kind of true, about 75% of operating profit over, I I was just looking at this last week. The first half of the last decade, about three quarters of their operating profit was subscriptions, was memberships. And then it fell to 70%. And then it fell to 65%. And then the most recent year was 57%. So Costco's not only, Costco's not only growing and doing well in operating profit, I think is up 10 or 11 percent annual lives over the past decade, perfectly acceptable. But they've also started to, to actually make a little bit more profit while keeping that hot dog at $1.50. So my favorite retailer, both as an investment, as well as just on a personal level, is

absolutely Costco. A close second is another one you mentioned, though, which is Home Depot. And Home Depot and Lowe's, yes, you're right, they kind of walk lockstep. I like Home Depot because, well, first off, they decided about a decade ago that they were kind of done break net expansion, and they kind of have gone to, you know, a couple of stores a year, opened, a few retrofitted, but they've really turned that company into running it for cash. And you just have to look at how the dividend has moved as skyrocketed up over the last few years, as well as the share repurchase.

Like, when they run that business for cash, all of a sudden, they are returning it all of it to people. And I'm kind of remembering the Bob Nardelli days back in, when was that, late 2000s? when he was just ruining that company because he wanted to apply GE earnings metrics or whatever. And since his ouster, it's just done so much better. And also, too, I kind of hold them as kind of semi-Amazon proof because you're probably not buying a couple thousand square feet of drywall from Amazon Prime and having it delivered. I imagine you're still going through the Walmarts or sorry, through the Home Depot's. And am I wrong to assume that out of both Home Depot and Lowe's, we're going to get

some color around presumably the benefit of commodity prices coming down? I mean, that has to help them. I mean, just all you have to do is look at the cost of lumber in 2022. And that's got to be accretive for them. I think so. Now, my question is going to be, I don't know the exact number, so I'm going to make them up. Fantastic. Let's just say, you know, well, because it's more about presenting a point. Let's say Lumber Crisis have come down 50%. Has Home Depot passed all that 50% to their buyers?

Has Lowe passed all that 50%? Have they passed 30% back to, like I am reminded here, here in the Great White North. We just raised interest rates about a month ago. We went up a full percentage point. The Bank of Canada raised it by a 100 basis points. And that day, I got an email from my local credit union talking about the higher interest rates they were paying on short-term deposit, short, you know, three months to five years. And miraculously, Chris, you know, they went up between 10 and 40 basis points. So, you know, so I was like, pass all those savings on to you?

Funny thing, isn't it? And so I'm kind of wondering, you know, if Home Depot and Lowe's and they're, I'm wondering if they've passed all those savings on to you. I'm willing to bet they haven't. So I think Home Depot, and then of course, Home Depot, we are emerging from pandemic closures. Those are further and further in the rear view, thankfully. And those are going to be, you know, but people spend a lot of time. on their houses because they had nothing else to do for almost two years. People spent a lot

of time and money on their houses. I kind of wonder what, if that's going to carry over or people have kind of gotten used to continued cocooning. How many companies have gone to a more hybrid work model? So there's more people working from home on the regular basis. Someone like me has been doing it for 20 years. It's kind of irrelevant. For folks who have been doing it for maybe two years and now have the option to work from home three days a week or what have you. Maybe they want some more creature comforts than Home Depot and Lowe's can provide. So I'm a lot more optimistic about those than I am about the Walmarts of the Targents.

Jim Gillies, always great talking to you. Thanks for being here. Thank you. Shopify is one company tied to retail that's tapping the brakes on its growth, but some companies are hitting the gas pedal. Mulvey and Sanmete Deo look at a few businesses playing offense in a tough environment. You're in a recession. We're not in a recession. Today we're looking at some of the companies playing offense in a challenging environment. Joining us now as Motley Fool senior analyst, San Mate Deo. Good to see us on meet. Good to see us. Ricky. So play in offense is a lot easier when the

market is raging upward. That's what Shopify did during COVID. And now some of those companies are feeling a little bit of a hangover. Yeah. So Toby, Toby Luke, he wrote in a company Y-Memma to Shopify, you know, we bet that the channel makes the share of dollars that travel through e-commerce rather than physical retail would permanently leap ahead by five or even 10 years. We couldn't know for sure at the time, but we knew that if there was a chance that this was true, we would have to expand the company to match. It's now clear that bet didn't pay off. And so it's this idea that, you know, you can go on offense when your stock price is soaring upward, interest rates are low, but then it becomes a lot more difficult when

you're in a more challenging market environment. And then, you know, Toby was very open in saying that, you know, we made these assumptions about the e-commerce market and adoption, and that just didn't play out. And, you know, I guess is that fundamentally what changed for Shopify? Yeah, you know, it's interesting because, you know, they made this big strategic bet, like you said, and one of their biggest mistakes, and one of the mistakes that a lot of companies have made during the pandemic that was that its industry growth would extend for a long period of time, and possibly even be a permanent shift. And so they grew their headcount expenses to scale up

to kind of anticipate that growth. Of course, they didn't take into consideration the effects on e-commerce, Shopify here, from a reopening of the economy and shifting consumer shopping habits once that occurs. So this ultimately led to a rapid ascent expense growth, followed by slowing revenue and decline of margins. Now the company has got to play defense,

laying off staff, cutting operating expenses to meet those lower revenue levels. While investors should be happy, Shopify is acknowledging this mistake and right-sizing, a big problem I see is the company may need to be more aggressive with implementing strategies to kind of grow revenues and gross profits, but because of what's happened, they're playing defense and kind of catching back up. In your view, are they playing smart defense? You know, it's interesting because I read an interesting take about how their take rates are

much lower than the competitors of Amazon eBay. So it's almost like when I read this analysis, it's they're almost under-earning. And, you know, maybe, you know, it's time to kind of close that gap and earn more and take more offense because, you know, you can only cut expenses for so long until you really need to ramp that revenue growth. Let's talk about some of the companies going on offense right now. You know, that's not just an idea that's a, good idea in and of itself. But, you know, when liquidity dries up, the market's down relative to all-time highs, that's when some companies were really able to grab market share. Any companies you follow that you see going on offense right now?

Yeah, you know, one company that comes to mind is Axon. They make tasers and body cameras. CEO, Rick Smith recently told the Wall Street Journal, right now I small opportunity. He said, yes, winter's coming. Now, let's embrace it. So he's buckling down on expenses for business travel on company swag, but he's kind of also encouraging, you know, an aggressive mindset in terms of playing offense in their business. He's got a, there's a good Wall Street Journal article about it. He's got a swag czar, and he kind of lamented to the reporter that not every single event needs a t-shirt. While the labor market is hot, you're still seeing a lot of these tech companies implement layoffs,

and AXon is very much in some ways welcoming that, saying, cool, more computer engineers. That's good for us, let's go find some talented ones for our company. Yeah, you know, there's a lot of shifts happening in the marketplace with companies, maybe people, employees leaving companies or things happening. Now's the time when you can kind of take advantage of those opportunities. Trade Desk also had a blockbuster quarter recently. That's another company that seems to be going on offense in a challenging environment. Yeah, you know, trade desks is, you know, they had great earnings report recently, raised guidance

in this kind of environment, which is very, very impressive, raising guidance when some companies are pulling back or not giving guidance. You know, many ad tech companies, ad companies like Facebook and, you know, ad platform companies are feeling the pinch from advertisers pulling back on spend. And some of those advertisers will pull back on kind of the low-hanging fruit stuff that they don't really need to do, but things like Google advertising is much more, much more prominent and impactful for them. But, you know, with companies pulling ads spend, Apple IDFA privacy changes, continue to ripple through the industry. TradeS is playing on playing the

offense and they have been for a while with their new UID2 ad platform, which is gaining traction, gaining partnerships and integrations with companies like Disney and AWS. And it's kind of, it's showing the results and they're they're very bullish on, you know, connected TV advertising and where they play in the market and how they can kind of capture share. Speaking of companies, play in offense, I think one frame to use is you look at a growing industry, take a little bit of a macro view, and then you look at the specific companies that are kind of poised to take market share. A few months ago, we visited, we looked at a company called exponential fitness. And, you know, like, you see a lot of fitness companies that are able to

use COVID as an excuse, or you see some companies kind of shrinking their footprint. This is one that his CEO Anthony Geisler has really never leaned on COVID as an excuse. And he's also very much leaning into an international expansion for exponential. Yeah, you know, he, you know, when COVID hit, he was very aggressive and fought very hard for his franchisees. When it came to, you know, renovations, fighting, fighting the government to get, you know, COVID relief and pausing royalties for his franchisees. and launching online platforms and digital platform for his franchisees. He did a very good job of, instead of blaming COVID, kind of going on the offense. And that's kind of continued, especially now with them signing more international agreements,

master franchise agreements in Japan and all across the world. One interesting story that recently came out that was very impressive to me was, on July 26 of 2022, its competitor, F-45 Holdings, came out with some rough news. announcing a departure of its CEO, reduction in global workforce, sharp-cut in his full-year guidance for revenue and earnings, and a removal of a financing facility for its franchisees. Stock loaned over 60% in a day, and usually this would be not such a great read-through for the boutique fitness industry. The next day in the morning, Exponential announced, quote, it expects to deliver strong results for the second quarter of 2022, has continued to

reinforce his position as the leading provider of Boutique Fitness globally. Additionally, quote, it's on track to meet or exceed guidance metrics for the year. And so in that press release as well, they had the announcer preliminary second quarter results, strong member growth, store visits, sales, AUV, you know, average unit volume growth for their stores. A very offensive move after, you know, F-45's disaster, you know, reassuring investors that were okay, you know. And I'm an investor in it myself and I was very pleased by it as well. Iron shares as well. The only way you can play offense in a tough environment is if you have the balance sheet to back it up. Some of the companies we've talked about, Axon, exponential trade desk. Any balance sheets there stand out to you is for companies that could continue to play offense in a tough environment. Yeah, absolutely. Trade desk, which we were talking about earlier offline about how you wouldn't think, like, tech companies have or some of these kinds of companies might have super strong. balance sheets but you know they have 1.2 billion of cash on on their balance sheet no debt so

they're well positioned to to continue to play offense like they've been doing accident as well no debt on their balance sheet 377 million dollars in cash again strong balance sheets that put them in a position to kind of take the offensive maneuvers exponentials balance sheet has some debt and it's okay but the main advantage for exponentials is a franchisor so you know launching in international markets, growing their stores. As a franchisor, those costs are typically on the franchisees to open up the stores. So they can grow and expand an environment without taking on too much heavy costs in this kind of environment. Now, we've talked about some of the companies with strong balance sheets playing offense.

Which companies would you like to see play offense, but maybe their balance sheet is holding them back. They don't have the ability now to go out and make smart acquisitions or really expand into new territories. The first thing that came to mind is Netflix. They're in a very competitive space. They're looking to find their next leg of growth. They've done very well on stream, and now there's a lot of competitors out there. You saw Disney recently reported that they have in combination more streaming subscribers than Netflix. They have plenty of have cash on their balance sheet, but they have about $14 billion of debt, and they have a large content spend annually of about $17 billion. That's kind of been, management recently said that that's

kind of where they're going to tap out at, and they're not going to continue to go higher. But I feel like that, the obligations that they have is going to keep them from making any big splash on the acquisition front to kind of build its ad platform or grow its gaming business. Now, they're working with Microsoft for their advertising platform, and that's probably going to be good. In fact, trade desks actually mentioned that that would be a good move for them. But, you know, the gaming business, they've made some small acquisitions, but to make a bigger acquisition to really drive home their position in that industry, they might be held back a little bit, and they'd have to grow it more organically than otherwise. San Mateo. Thank you for your time. Thank you, Riggi.

As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.